Part 2 of our series: A House Flipping Strategy for Buy-and-Hold Investors
Flipping houses can be a very complicated and risky investment strategy—unless you change your point of view, which is exactly what we’re doing in this 2-part blog series.
In the first post, we introduced the concept of “flipping to yourself,” contrasting it with traditional home flipping. We highlighted the downsides of traditional house flipping, the advantages of a buy-and-hold strategy, the ins and outs of rehabbing properties, and how doing so strategically can help to spur substantial profits.
But the real magic of this approach lies in the financials, which is what this 2nd installment is all about. Here, we’ll hash out the dollars and cents of flipping to yourself, examining how to do it and why your real estate portfolio is likely to thank you for it.
Learning from the Rehabbing Trenches
In our last post, we shared the story of our owner’s investing origins. The pivotal moment came shortly after his first foray into real estate, with what was marketed as a turnkey property. Turned out, it was less perfect than promised—and his ensuing experience sparked a pivotal shift.
Shortly thereafter, he invested in a very different property nearby—a home that needed significant work but was available at a bargain price. With a vision of enhancing its value and maximizing profits, he embarked on the remodeling journey himself (assisted extensively by his father, who brought a wealth of skill and knowledge to the project).
Through this hands-on experience, our owner gained invaluable insight into the rehabbing process, as well as a firm foundation in the critical importance of bringing quality properties to market.
That belief has only grown stronger over the years, and it helped form the foundation of our property-management company. In a nutshell, that core philosophy hinges on 3 key factors that are essential for attracting and retaining great tenants:
- Property Quality: The nicer the property, the higher the caliber of tenants it attracts.
- Fair Market Rent: Pricing properties competitively ensures they are appealing and profitable, while still affordable.
- Excellent Property Management: High-quality management is crucial for keeping great tenants for the long-term.
The First “Flip to Self”
By project’s end, our owner had transformed a modest investment into a high-quality property with significantly enhanced value. At this point, he could have sold it for a substantial profit. But he chose to “flip it to himself” instead—holding the property as a rental, while also pulling equity out.
Why? For one, due to the improvements made through rehabbing, the property now rented at a significantly higher rate than it would have originally—and with a higher profit margin than a turnkey property, due to the lower initial investment.
Moreover, it presented an opportunity to pull equity out, leveraging the value he had forced into the property to support future investments.
This experience was eye-opening, marking the beginning of a focused, value-add investment strategy that has since guided our long-term goals.
To help illustrate the financial side of this approach, let’s work through a detailed example, showing step-by-step how this strategy can be replicated to achieve similar success:
Flip-to-Own by the Numbers: A History
Because this is where we began, let’s first pretend we’re back in 2010. We’ll start with some simple numbers that—while not very realistic today—were true of the time. After we outline the concept, we’ll look at how this applies in the current climate.
Imagine you bought a house for a great price, planning to renovate it, flip it to yourself, and rent it out. Here’s your baseline:
- You paid $50,000 for the property.
- The rehab cost you $25,000.
- So after rehab, you were all in for $75,000.
Option 1: Sell
Prevalent logic claims that if you put $25k of strategic improvements into a property, you should be able to flip that home right away, listing it and selling it for a profit. In those days, maybe you could plan on a $125,000 sale.
And there were comps all over the market showing that people were out there making a $50k spread, maybe $40k after expenses.
Sounds nice! Why not?
Option 2: Flip to Yourself
At Epic, we’d take this same property and make the same strategic improvements. So we’d also start at $75,000 all-in.
But we wouldn’t do a traditional flip. Instead, we would hold the property as a long-term rental.
At the same time, we would pull our capital back out, which involves packaging multiple properties together into a commercial blanket loan. (This is much easier to do when working with multiple properties, because lending standards make it very difficult to hold many individual mortgages…More on commercial blanket loans below.)
When ready, we’d go to the lender and have them appraise a group of homes at current market value, as if we had flipped them—i.e., appraisals that included those great renovations we’d made. Then, we would pull our equity out at about 75% loan-to-value.
So we’d get our $75,000 back.
In fact, often, we’d get even more than we put in (in the above example, about $95k).
Tax free.
Then rent out the property and start making money on it.
See the magic?
Flip-to-Own by the Numbers: Today
When Epic perfected the practice outlined above, the price-to-rent ratios were very high, which meant that our debt service coverage ratio was much higher. So to be fair, this approach was far simpler back in 2010. But that doesn’t mean it isn’t possible today. We still do it regularly!
Yes, lending is a bit tighter, and higher prices relative to rents hurt your debt-service coverage ratio (DSCR). But nonetheless, flipping to yourself is still absolutely do-able—and beneficial!
The trick is to implement it much more selectively. And, in the current market, the hardest part is finding the right deals.
To start, we reverse engineer the math. Ultimately, we’re looking for properties that have a strong enough spread potential that, in theory, we could flip them and make money.
We’ve always used $20k as our metric for a net profit spread, and that hasn’t changed. So to update our previous example, let’s say:
- We pay $80,000 for the property.
- The rehab costs us $30,000.
- We’re now all in for $110,000.
On a traditional flip, we would want to net $20k. So let’s use that as a target. Adding 8% selling expenses, we would want the after repair value (ARV) to be at least $140k. (Of course, we’re ignoring holding costs and using round numbers to keep things simple.)
If you can meet the above valuation metrics, the next step (which wasn’t typically a problem when acquisition/rehab costs were lower) is to determine if the property will cash flow enough to cover the debt.
Lets make some assumptions:
- Rent: $1,600
- Maintenance: $100
- Taxes: $300
- Insurance: $75
- Property Management: $99 (flat-rate property management is best)
- Net Operating Income: $1,025/month
Assuming 75 – 80% LTV, a 25-yearr amortization, and a 6.5% interest rate, the payment on a $110k loan would be $745/month.
This would leave you with about a 1.4 DSCR, and anything over 1.2 should be sufficient.
So if you can find a property for $80k that needs $30k of work in order to be worth $140k, and it will achieve $1,600 in rent, you can flip this property to yourself, get all of your capital back out, and have a cash-flowing rental property.
Better yet, if it appraises higher, you may even be able to keep some additional capital—as long as you can stay within the debt-service constraints.
As you can see, this approach can take your need for capital out of the equation.
Flip to Yourself with Investors
If you have investors, there’s no need to avoid this approach or feel intimidated by how to manage it. In fact, we’ve found that it works well with private money lenders involved as well! Here’s how we do it:
When purchasing the property, we’ll put a first position private money mortgage on the property. Usually, that lender will fund purchase or, sometimes, purchase plus rehab, especially once you have a track record of success.
We pay a good rate for that—perhaps 12% – 15%. Then, when the rehab is complete (usually in 6 – 8 months), we refinance the private lender out and put more favorable rate financing in place. Yes, this approach lessens profit; but it can allow someone to get started with very little money out of pocket.
The timing of this approach is no different than if we flipped the property and sold it.
Our ideal strategy is to package 5 – 7 properties together at one time and refinance them all with a commercial blanket loan. (This can be done with as few as 3 properties.) Then, at closing, all private lenders get their initial capital plus interest back. And we get to keep the properties, along with any additional proceeds.
In our experience, the investor doesn’t care how they get paid back—whether the funds come from a credit union or if we sold the property. They just want their return, within the agreed upon timeframe, and they’re happy.
Conclusion: Don’t Chop Down Your Tree
If you purchase and improve a property, making it the best property on the market, you’ve just created an incredible, income-generating asset. Like a healthy tree, this asset should continue to grow and yield fruit (aka money).
Don’t chop it down by selling it.
As always, the secret to making this work in the long term is to focus on getting and keeping great tenants. Which means offering the best property, at a fair price, with great property management.
In other words, none of this works without excellent property management that helps you get the right tenants in and keep them. So let’s talk.
Pass It On: Home Flipping to Yourself & More
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